Inflation eases; monsoon holds key to rate cut

A vendor selling vegetables waits for customers at a vegetable wholesale market in Chennai July 16, 2012.Babu

NEW DELHI (Reuters) - India's headline inflation slowed to its lowest level in five months in June helped by a moderation in fuel prices, adding to pressure from business leaders for a cut both in interest rates and fuel subsidies to help revive the lacklustre economy.

The wholesale price index (WPI) -- India's main inflation gauge -- rose a lower-than-expected annual 7.25 percent in June, its slowest rise since January, following a drop in prices of some fuel items. Wholesale prices rose 7.55 percent in May.

Businesses want lower interest rates to help drag Asia's third largest economy back from a nine-year low of 5.3 percent GDP growth in the first quarter of 2012.

But a faltering monsoon, key to volatile food prices, tempered expectations of a rate cut, with the government warning inflation could accelerate without more rain.

The government bond yields and overnight index swaps (OIS) rates fell after Monday's data, but the rupee and stock market flattened after an initial bump, as traders calculated that at around 4.9 percent, core inflation was too high to significantly increase chances of a rate cut at the Reserve Bank of India's July 31 policy meeting.

"I do not expect this number to prompt the RBI to immediately cut rates," said Shubhada Rao, Chief Economist at Yes Bank in Mumbai. "The inflation expectation still remains elevated, and the outlook is cautious because of the performance of monsoon, and its impact on food prices, as well as the impending and much awaited hike in fuel prices."

Ingrained inflation is India's most stubborn economic problem and means the country's interest rates are higher than most other major economies.

Galloping prices have also dented Prime Minister Manmohan Singh's popularity in the poverty stricken country, and he has delayed hiking diesel and other fuel prices to tackle a gaping fiscal deficit.

A labourer sits inside a truck loaded with sacks of onions at a wholesale vegetable market in Jammu June 14, 2012.Mukesh Gupta/Files

"With the price of every food item soaring, it is becoming increasingly difficult to muster up two proper meals for my family", said Pawan Kulshreshtra, a junior official at a private firm in Lucknow.

"The only option left with someone like me is to cut down on the quantity of vegetables, otherwise it would become impossible to make two ends meet."

FOOD PRICES

Food prices, which rose 10.81 percent in June from a year earlier, up from 10.74 percent in May, have been mainly responsible for India's long struggle with inflation.

"If the monsoon turns out to be different from our expectation then it can push up inflationary expectation, then inflation can go up. Therefore, much depends on it," warned the prime minister's economic advisor C. Rangarajan.

Annual fuel inflation was 10.27 percent in June, down from 11.53 a year earlier. A weak Indian rupee has largely offset falling global crude prices and prevented fuel inflation slowing further.

Despite the political restraints, India's fiscal credibility is on the line after two global ratings agencies recently threatened to downgrade its sovereign debt to "junk" status, and a decision on hiking fuel prices is widely expected after a presidential election on July 19.

U.S President Barack Obama added to pressure on the government, suggesting in a weekend interview with the Press Trust of India news agency that India made it too difficult for foreign companies to invest.

India's benchmark 10-year bond yield was down 7 basis points from the previous close to 8.03 percent.

Additional reporting by Manoj Kumar and Arup Roychoudhury; in New Delhi, the Mumbai bureau and Sharat Pradhan in Lucknow; Editing by Frank Jack Daniel and Alex Richardson